Keynesian Disequilibrium Dynamics: Convergence, Roads to Instability and the Emergence of Complex Business Fluctuations

Quantitative Finance Research Centre Research Paper Number No. 146

33 Pages Posted: 2 May 2006

See all articles by Pu Chen

Pu Chen

Bielefeld University - Department of Business Administration and Economics

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics

Hing Hung

University of Technology Sydney (UTS) - School of Finance and Economics

Date Written: March 2006

Abstract

We reformulate the traditional AS-AD growth model of the Neoclassical Synthesis (stage I) with a Taylor policy rule replacing the conventional LM-curve, with gradually adjusting wages as well as prices, and with perfect foresight on current inflation rates and an adaptively revised notion of an inflationary climate in which the economy is operating. We compare this approach with the New Keynesian approach, the Neoclassical Synthesis, stage II, with staggered price and wage setting and find various common components, yet with radically different dynamic implications due to our treatment of the forward-looking part of our wage-price spiral. We show for a system estimate of our model that it implies qualitatively local asymptotic stability and when its estimated form is simulated in response to isolated shocks strongly damped business fluctuations, due to a stable interaction of goods market dynamics with the interest rate policy of the central bank and due to a normal working of a real-wage feedback chain. These results are however endangered - leading in fact to economic breakdown - when there is a global floor to money wage inflation rates. In this case, the return of some money wage flexibility in deep depressions is of help in restoring viability of the model, thereby even avoiding explosive dynamics and the collapse of the economy. This situation leads to viable, but complex business fluctuations.

Keywords: DAS-DAD dynamics, wage and price Phillips curves, real interest effects, real wage effects, (in)stability, persistent business cycles, complex dynamics

JEL Classification: E24, E31, E32

Suggested Citation

Chen, Pu and Chiarella, Carl and Flaschel, Peter and Hung, Hing, Keynesian Disequilibrium Dynamics: Convergence, Roads to Instability and the Emergence of Complex Business Fluctuations (March 2006). Quantitative Finance Research Centre Research Paper Number No. 146, Available at SSRN: https://ssrn.com/abstract=890427 or http://dx.doi.org/10.2139/ssrn.890427

Pu Chen

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany

Hing Hung

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

Haymarket
Sydney, NSW 2007
Australia

HOME PAGE: http://www.business.uts.edu.au/finance/